Economists have various theories that seek to explain the economic cycle. Which of these theories best explains the 2008-2009 UK recession?( 20 marks)

Topics: Macroeconomics, Unemployment, Economics Pages: 3 (955 words) Published: February 19, 2014
Economists have various theories that seek to explain the economic cycle. Which of these theories best explains the 2008-2009 UK recession?( 20 marks)

A recession is defined as a decline in GDP for a period of two quarters or more. However, this definition does not take into account that a decline in GDP is usually accompanied by a decline in investment, employment and spending levels; which all contribute to total economic welfare and may continue for longer than the initial decline in GDP. The economic cycle is an explanation of how economies work, suggesting that they typically follow a pattern of 1) expansion, 2) peak, 3) recession, and 4) recovery. There are multiple suggested causes of the economic cycle but economists are yet to universally agree.

The 2008-2009 UK recessions began with a financial crisis initiated in America. It started in 2007 when US banks gave sub-prime loans to consumers with poor credit ratings. Banks then sold the loans as CDOs to investors who, upon discovering the consumers cannot afford to pay the loans, refused to take on more CDOs. A fall in house prices as well as a rise in interest rates lead to consumers being unable to pay any debts. Credit froze and banks no longer leant to one another as they were unsure how many bad loans the other banks had given out and hence, how able they work to pay back any debts! The impact soon spread internationally as firms cancelled sales of bonds worth millions and governments had to give emergency loans to banks (UK government loaned $400 billion to 8 UK banks for a stake in the banks). Interest rates were cut in order to increase lending and spending but the damage was already done.

There are many possible explanations for the occurrence of the 2008-2009 recessions; one being the Minsky moment .The Minsky moment suggests that long periods of prosperity and investment alongside unsustainable growth lead to massive debts which, when the price of assets falls, will be unaffordable by...
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